This is a guest post by Ahmad Hassam
Prices trend. Trendlines are drawn by connecting two or more points of support and resistance. An uptrend means a series of price bars or candles exhibiting higher lows, higher highs or higher closes. Similarly, a downtrend means a series of price bars or candles showing lower highs, lowers lows or lower closes.
An uptrend line or support is drawn by connecting the higher lows with a straight line and extending that into the future. Similarly, a downtrend line or resistance is drawn by connecting the lower highs with a straight line and extending that into the future.
Trendlines are a favorite tool of the traders as markets respect them. In trading, it is the market that defines our decisions and it is the trendline that defines the market parameters. Uptrends act as areas of support whereas downtrend lines act as areas of resistance. Trendlines have to be updated as markets move through time.
In making their trading decisions many traders tend to forget the long term trendline in face of a fluctuating account balance. As you gain experience as a trader, you will start respecting the long term trendlines. In doing trend analysis, you need to understand that as there are short term, intermediate term and long term trends so are the trendlines that need to be updated continuously.
Trendlines are very useful for pointing out market direction. Having a trendline in place on the chart can be a good reminder of the market’s current direction. The more steeper the angle between the main trendline and price becomes, the more likely it becomes that the price action will revert back towards the trendline. This slope acts as a rubber band that tends to snap back. This is the basis for the market corrections.
So every time the market increases its speed and makes a larger and larger angle from the oldest or the longest trendline, it sets itself up for a counter trend rally back towards the older or the longer term trendline. As experienced traders tend to trade larger positions, it is infact their buying back of contracts after accelerated sell offs that sets the counter trend process in motion.
Once a market makes a counter trend move, we draw a new short term trendline. This new short term trendline will help you predict the next price correction. When you see the price angling away from the new trendline, the market is getting closer to making a counter trend correction.
A trendline can tell you when a trending market will revert to a counter trending correction. As each new trendline becomes steeper, it is time for the market to make a correction. It is unnecessary for you to know when that correction will happen. When you see the new trendline getting steeper, exit a portion of your position being mindful of the fact that prices have a tendency to migrate back to its longer term trendlines.